The COVID-19 Stock Market Downturn: Expected Growth or Discount Rate?

27 Pages Posted: 15 Jun 2020

See all articles by Pascal Böni

Pascal Böni

Tilburg University - TIAS School for Business and Society and Tilburg School of Economics and Management

Heinz Zimmermann

University of Basel - Center for Economic Science (WWZ)

Date Written: June 15, 2020

Abstract

We use the Gordon (1959) constant growth model to explain stock returns of S&P500 index constituents during the COVID-19 implied market downturn and subsequent V-shaped recovery. Stock returns are largely affected by a change in the implied growth rate w and only to a lesser extent by a change in discount rate k, the latter typ-ically used to explain stock returns in the classical asset pricing literature. We reach this conclusion by using ordinary least squares (OLS) regressions of stock returns on the unobservable Gordon factors, which we estimate from firm level valuation ratios D/P, P/E and P/B. The effects from a decrease in implied growth outweigh those from an in-crease in discount rate by a factor of approximately 1.6 to 1.7, implying the COVID-19 stock market downturn is of long-term rather than transitory character. We evaluate the performance of the Gordon factors for an early period of the Global Financial Crisis (GFC) and find strong support for our observations.

Keywords: Stock market valuation, COVID-19 stock market downturn, valuation multiples, Gordon model

JEL Classification: G12, G32, E44

Suggested Citation

Böni, Pascal and Zimmermann, Heinz, The COVID-19 Stock Market Downturn: Expected Growth or Discount Rate? (June 15, 2020). Available at SSRN: https://ssrn.com/abstract=3626959 or http://dx.doi.org/10.2139/ssrn.3626959

Pascal Böni

Tilburg University - TIAS School for Business and Society and Tilburg School of Economics and Management ( email )

Warandelaan 2
TIAS Building
Tilburg, Noord Brabant 5037 AB
Netherlands

Heinz Zimmermann (Contact Author)

University of Basel - Center for Economic Science (WWZ) ( email )

Peter Merian Weg 6
Basel, 4002
Switzerland
+41 61 267 33 16 (Phone)
+41 61 267 08 98 (Fax)

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
140
Abstract Views
589
rank
225,839
PlumX Metrics